Which Trends in Industrial Real Estate Will Survive the Pandemic?
The COVID pandemic spurred demand for storage medical equipment, non-perishable food, and other emergency supplies
While the pandemic might have accelerated growth for many industrial tenants, the challenge for investors in the sector will now be twofold: navigating an increasingly competitive market for industrial properties and analyzing which emerging classes will have the most staying power after COVID.
Of the recent industrial uses to emerge, last-mile delivery is the most recognized, perhaps because of the high-profile credit tenants associated with it. As new last-mile projects are built and stabilized, the competition to purchase them will be unprecedented. Due to zoning as well as the sheer acreage necessary to build last-mile delivery centers in New York City, there are a relatively small number of sites suitable for this type of development.
While e-commerce growth shows no signs of slowing down and will fuel demand to occupy these centers, the supply in NYC will eventually plateau due to the limited number of suitable sites. When these modern industrial buildings do eventually lease up and sell, capitalization rates can be expected to be incomprehensibly low as institutional investors with too much perceived exposure to other asset classes jockey for a very limited number of these deals.
In fact, the market is already honing in on sites with the physical attributes and zoning suitable to convert or build a modern industrial product. For instance, in the fourth quarter of 2020, Brooklyn industrial transactions in industrial business zones, where taxes on new buildings will be stabilized at pre-improvement tax amounts for up to 25 years, averaged $537 per square foot. That marked a 24 percent premium over non-IBZ sites.
Physical attributes impacted pricing as well. In the same quarter, Brooklyn industrial properties with ceiling heights of at least 20 feet traded for an average of $549 per square foot, or approximately 23 percent higher than properties with lower ceiling heights. Similar trends were noted in other boroughs.
There were other signs pointing to increased future development. Demand for industrial-zoned land also ticked up, particularly in the second half of 2020. Due to the moderate replacement cost and antiquated stock of industrial buildings in NYC, land bankers and investors alike believe buying and holding industrial-zoned sites can be profitable. In the interim, lease rates for land have increased and could continue to rise as more businesses see value in providing parking for their employees, many of whom drove to work instead of utilizing public transportation during the pandemic.
Other, less conspicuous usages have turned up as well. The pandemic spurred increased demand from government agencies, health care providers, and nonprofits to acquire storage for essential medical equipment, non-perishable food, and other emergency supplies.
While there are questions as to how much the country will stockpile moving forward, if nonprofits, health care institutions, and government bodies do shift to a mindset of over-preparation in the future, the impact on leasing demand for storage will be significant.
Cold storage is another evolving use. Consider one year ago, when there was essentially one sizable cold-storage tenant in the New York region. Since the pandemic, the grocery subscription industry has splintered into a hyper-specialized market with new ventures offering organic meals, dietary restriction plans, and the list goes on. As these enterprises continue to expand their presence in the region, the demand for smaller yet modern cold-storage facilities will rise.
The need for manufacturing space has also risen rapidly. A growing craft movement, coupled with political aspirations to increase domestic manufacturing and reduce dependence on other countries, has fueled growing demand for modern manufacturing space. If GDP growth continues and a “buy American” movement takes off, manufacturing real estate startups will be well-positioned for growth.
Cannabis is the last trend to watch. Even if New York receives federal assistance to help with 2020 budget shortfalls, the state’s ability to consistently balance a budget moving forward is murky. As politicians seek revenue sources that are alternatives to raising taxes, the list of legal uses for cannabis could grow, which would impact the industrial market as it has in other states. Because the federal government still classifies marijuana as a dangerous drug, the obstacles to owning, financing, and insuring cannabis properties are substantial and, as such, institutional capital will continue to avoid the product altogether. However, that will create an opportunity for entrepreneurial-minded investors with a stronger stomach for risk.
Certain use types within the industrial asset class will have staying power post-pandemic. Last-mile distribution, industrial land-banking, and cold storage will continue to thrive in a competitive market. Other uses, such as storage, maker space, and cannabis could see growth and less competition, but that will come at the cost of much greater risk as the market tries to get its bearings in the post-COVID frontier.
Daniel Tropp is the founder of AEBOV Industrial Real Estate Brokerage and host of “Help from AEBOV,” a podcast covering the New York-New Jersey industrial markets.